What’s in a name?
With recent reports suggesting that one in three Canadians are concerned about their finance due to the pandemic, Financial Literacy Month is a good opportunity to review how the flexible Tax-Free Savings Account can serve you now and to save for retirement.
In my opinion, it is the most misunderstood and under-used savings and investment vehicle available, quite possibly because the name implies it is only for saving. In fact, there is so much more that you can do inside a TFSA to generate growth and income which are non-taxable. Better names for the TFSA would be the Tax Free Investment Account, or the Tax Free Savings Plan.
TFSA’s can hold investments such as mutual funds, segregated funds, ETF’s, stocks, bonds, and more. The growth earned on these vehicles is yours to withdraw, without any tax remitted to the CRA. What is more, you can recontribute the following calendar year any amounts withdrawn (including the growth).
Example: Let’s assume you have a TFSA to which you have contributed $50,000 over some years and the total value of the investments is now $60,000. Should you have a need for the total $60,000 for anything at all (a car, vacation, wedding, school, etc.) you can withdraw it in 2020, and recontribute in 2021 or later, not just $50,000, but all $60,000.
Like the RRSP, whenever you do not use up all your TFSA contribution room in any year, the unused amount is carried forward year after year. Unlike the RRSP, you don’t have to collapse the TFSA at age 71, and you can continue contributing to it as long as you like. Another advantage is that withdrawals are not counted as “income” on your tax return, so the money withdrawn doesn’t affect government benefits, pensions or disability amounts.
Sun Life recently published a good article on the versatility of the TFSA.
The fine print: a few aspects of the TFSA to be cautious about
- No creditor protection: Unlike the assets held in RRSP, the assets held in a TFSA are not protected from creditors in the event of bankruptcy or a financial judgement that results from legal proceedings against you. (Holding segregated funds in your TFSA may protect you in such a case.)
- Penalty on over contributions: if you contribute more than your allowable TFSA contribution room, you will be subject to a tax equal to 1% of the highest excess TFSA amount in the month, for each month that the excess amount remains in the account.
- CRA Reporting often out-of-date: I have witnessed in my own records and clients have also reported to me that the contribution room shown in “my account” on the CRA website usually reflects eligible contribution room of the previous year. I advise you to keep your own written record of contributions and withdrawals to avoid overcontributing and possibly incurring the above 1% per month penalty.
- TFSA not the place to hold dividend-paying shares of U.S. corporations. The Internal Revenue Service in USA does not consider the TFSA to be a pension plan. Thus, Canadians in most cases are subject to a 15% U.S. tax withheld on dividends paid on shares of U.S. corporations.
Contact me if you want to open a TFSA, or transfer your TFSA to Assante.
One last word of caution on transferring a TFSA to another institution: there are no tax consequences if your issuer completes a direct transfer on your behalf. Don’t make the mistake of withdrawing the funds yourself and contributing those same funds to another TFSA. In this situation, the funds will be treated as a regular contribution which will reduce your TFSA contribution room for the year.
Understanding the TFSA – it’s just good advice!